These not-terribly-famous words were spoken by an early 1900s American baseball player named "Wee" Willie Keeler. Keeler was below average in stature but had a phenomenal record at the plate, hitting over .300 in 16 of his 19 major league seasons. When asked about his success, his response and advice to other hitters was simply: "Keep your eye clear, and hit 'em where they ain't."
It makes perfect sense - if you want to get on base you have four basic options: 1) Hit the ball someplace it will land safely but provides you adequate time to get to first base or beyond; 2) Hit the ball over the fence (a homerun); 3) Get the opposing pitcher to throw four 'balls' before he throws three 'strikes;' or 4) Throw yourself in front of a 90mph flying rock and advance to first base on a 'hit-by-pitch.' From personal experience I can tell you that-despite it being the one most within the batter's control-Option 4 is the least appealing.
Come on, everybody else is doing it….
The "Hit 'em Where They Ain't" philosophy applies rather well to the world of investments, too. I'm referring, of course, to the so-called herd mentality - this is the idea that people are most comfortable doing what "everybody" else is doing. However, when it comes to successful investing, sometimes it can pay to stray from the herd.
What's the herd up to right now? Well, after hemming and hawing for four years, retail investors are starting to feel comfortable dipping their proverbial toes back into the stock market. This comes after most U.S. markets have more than doubled in value. In fact, some folks are warming to the idea that bonds may not be as "safe as they thought," at least in terms of inflation protection. And we've been hearing for the past two years that things in Europe can only get worse, the Emerging Markets will continue to get decimated by diminishing global demand for their chief exports (raw commodities) - the U.S. is the world's "cleanest dirty shirt."
But what about the dirtiest dirty shirt?
I think it's important to remember that everything is relative. Let's continue with the "cleanest dirty shirt" analogy for a moment: What makes an investment "dirty?" Is it the fundamentals of the underlying assets, or is it their potential return on investment? Is it possible that the two are inversely correlated? Consider U.S. Large-Cap Value stocks right now versus Emerging Market stocks. I would argue that the former looks much "cleaner" with respect to fundamentals - the U.S. financial/banking system is slowly but surely cleaning up its act and our stock market has recovered everything that was lost in 2008 and then some. The emerging markets, on the other hand, look pretty "dirty" right now - the index (NYSEARCA:VWO) is down double-digits so far in 2013 while the S&P500 is up double-digits, and sentiment is about as negative as it gets.
The S&P500 is up more than 30% over the past five years:
….while the emerging market index is perfectly flat:
"Keep your eye clear…."
Let's not forget about the first part of Willie Keeler's advice - keep your eye clear. In other words, we need to be sure we are looking out for any and all potential pitfalls to our argument.
If left with no other wardrobe choices, I suppose I want to be wearing the cleanest dirty shirt. But when it comes to my investments, maybe I want to consider the dirtiest dirty shirt for a portion of my portfolio. After all, which asset may have the greater potential upside from here? Is there really a great deal of potential downside in the emerging markets at this point? Another 10%, perhaps? Is there not at least as much potential downside in the U.S. markets, taking into account political risk alone?
Another thing to consider is that VWO offers more than a 4% yield at its current distressed value - further downside may be limited from that standpoint as well (every 10% reduction in price will add 11% to VWO's effective yield). Using the most rudimentary example, where Security X pays a $1 dividend per year and currently trades at $10 per share:
$1 / $10 = 10.00% Yield
If the price of Security X drops by 10% (to $9 per share):
$1 / $9 = 11.11% Yield (an increase of 11%)
So the argument is not to replace your portfolio's exposure to U.S. stocks with Emerging Markets - however, it may be a good opportunity to ensure that your diversified portfolio includes an allocation to the world's dirtiest shirt….
Have a great week!
Disclosure: I am long VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.